What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Packaging Corporation of America (NYSE:PKG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Packaging Corporation of America:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = US$892m ÷ (US$7.5b - US$806m) (Based on the trailing twelve months to March 2021).
So, Packaging Corporation of America has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Packaging industry average of 11% it's much better.
In the above chart we have measured Packaging Corporation of America's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Packaging Corporation of America.
How Are Returns Trending?
When we looked at the ROCE trend at Packaging Corporation of America, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 13% from 17% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
Our Take On Packaging Corporation of America's ROCE
To conclude, we've found that Packaging Corporation of America is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 109% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
One more thing to note, we've identified 2 warning signs with Packaging Corporation of America and understanding them should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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